When a seller and a buyer, i.e. order or quote owners, agree to a particular price for a financial instrument they complete a trade. I.e. they complete a verbal, or electronic, transaction involving one party buying a financial instrument from another party. The trades are typically initiated and completed by trading participants; such as individuals, firms, dealers (who may be either individuals or firms), traders and brokers or sometimes by the order owners themselves. Trading of financial instruments is generally performed on an exchange, i.e. a trading venue and the trading is typically done through brokers, or traders, who buy or sell the financial instruments on behalf of the order owners. Thus, there are a variety of exchange participants which are coupled to an automated exchange through the members of the exchange. The term “financial instruments” is used herein in a broad sense and encompasses any tradable item i.e. securities, derivative or commodity, such as stocks, bonds, cash, swaps, futures, foreign exchange, options, gas electricity and so forth, or group of items that is traded through matching of counterparty orders (bid, offer).
A conventional automated exchange typically receives order input data, in the form of data messages, from external devices used by traders, or brokers. The traders, or brokers, submit orders and/or quotes (or alterations/cancellations thereof) to the automated exchange for purposes of trading. In this context, an order is a request to sell or buy a financial instrument from any trading participant of the automated exchange and a “quote” may be an “offer” price, a “bid” price, or a combination of both an “offer” and “bid” price of a financial instrument, and is determined from quotations made by market makers (or dealers).
The orders/quotes may relate to buying and/or selling of any type of financial instrument. In particular, the input data to the automated exchange can be an order data message that represents the placing of a new bid or sell order, or a new quote. The order data message can also represent the change of an existing bid or sell order, or a quote. In addition, the order data message can represent a cancellation/change of an existing bid or sell order, or a quote.
FIG. 1 illustrates a conventional automated exchange system 100 comprising trader terminals 110 that are used for issuing order data messages, i.e. input data received by the automated exchange 140. The trader terminals 110 are connectable, for example over the internet 120, or over some other connection means like a dedicated fiber 120B, to an electronic marketplace, i.e. an automated exchange 140. The automated exchange 140 can be hosted on a computer server or a cluster of computer servers. Sometimes the trader terminals 110 are connected to the automated exchange 140 through an entry gateway 130. The entry gateway 130 is connected to, or being a part of, the automated exchange 140 and is configured to receive market actions, i.e. orders and/or quotes from the trader terminals 110. An entry gateway 130 is usually in connection with the automated exchange 104 on a dedicated network and forwards the market actions to the automated exchange 140 and further usually broadcast updates back to the trader terminals 110. It should however be understood that information being communicated to and from the automated exchange 140 and the trader terminals 101 could be communicated via a single communication path.
While the trading terminals 110 in FIG. 1 are illustrated as trading terminals that traditionally are associated with manual input of market actions, the trading terminals 110 can also be implemented as algorithmic trading units, sometimes termed automatic order generators, having manual input means for control of the algorithmic trading unit. The algorithmic trading unit is pre-programmed with instructions to automatically generate sell and buy orders and quotes (or changes/cancellations thereof) in response to input data received from the automated exchange 140. The trading terminals 110 also represent market makers inputting quotes to the automated exchange 140.
There is a constant need and desire to improve upon existing automated exchange systems and to provide solutions that operate with fewer drawbacks than pre-existing automated exchange systems. Also, due to today's frenetic markets and recent events in the financial industry; i.e. such as the flash crash of May 2010, market regulators require stricter control of financial exposure of participants and members of an exchange.
The financial exposure can be seen as the aggregated sum of all quotes and orders submitted intraday to an exchange, from a specific customer or participant of said exchange. For example, the financial exposure could be modeled as a maximum risk limit, which could be defined as: e.g. all users from Goldman Sachs could be allowed to have a total pending, intraday, volume of $1000 Million on the NASDAQ OMX Stock Exchange. This would in the above example constitute the intra-day maximum risk exposure which is allowed for Goldman Sachs.
Currently, many securities firms manage their risk and their clients' risk on an end-of-day basis. I.e. the total financial exposure is measured in regards of trades made until the end of each day. Other securities firms measure the total financial exposure based on order book content. I.e., the total financial exposure is measured ‘post-order’. That is, after the incoming order is received and processed by a matching engine and thereafter being placed in an order book. A disadvantage with present solutions is the possibility that the aggregated sum of all pending orders in an order book, from the specific customer, will exceed a total risk limit for that specific customer. In practice, this results in new orders being accepted and inserted into the order book, even though the total financial exposure limit of said specific customer is surpassed. This approach means that for these firms their intraday exposure to trades could exceed risk profiles established by contractual, statutory and/or regulatory guidelines. These risks could result in (i) the inability of the firms to meet capital adequacy requirements, (ii) the firms having to take contractual actions to protect themselves that could be detrimental to their clients or (iii) the firms having to take client exposures onto their own books to address the risk.